Prof. Dr.

Matthias Raith
Department of
Economics and Management

Winter Semester 2016/17

Business Decision Making

Exercises No. 4
1) Consider the St. Petersburg game with a payoff of 2n Euros if Heads shows
up after n rounds and a decision maker with a utility from money characterized by the function u(x)=ln(x), where x denotes the amount of Euros received. How high is the decision makers certainty equivalent of this lottery?
2) In the process of restructuring the Lien Corporation it is not yet clear how
many jobs will be lost. According to an estimate the number could be anything between 0 and 2000. The workers' union is indifferent between a 50-50
lottery, where either zero or 2000 jobs are lost, and a sure number of 500
dismissals. For other lotteries the union finds
{(0,0.5), (500,0.5)} ~ {(200,1)} and
{(500,0.5), (2000,0.5)} ~ {(900,1)}.

a) Sketch the union's utility function under the assumption that it has a plausible continuous form.
b) What attitude towards risk does the shape of the utility function indicate?
c) Three policy plans are suggested. With plan a, the forecasted job losses
are 300, 600, and 1000, each with probability 1/3. With plan b, 500 jobs
will be lost for sure. With plan c, no jobs will be lost with probability 1/4,
300 with probability 1/2, and 2000 with probability 1/4. Which of the three
plans should the union prefer in order to be consistent with its utility function?
Adapted from: Eisenfhr, Weber: Rationales Entscheiden, 1999